The Economy Guy

Issue: 12/14/07 Friday

I bet you haven’t seen the word Stagflation yet in the news today. However, that is exactly what the Fed is worried is happening. It is a combination of a stagnating economy (think going into recession) and inflation – at the same time. It’s happened before, and it is ugly. It takes most of the tools away from the Fed that they usually use in either a recession or an inflation.

What was the bad news?? It was that the CPI (Consumer Price Index) jumped WAY up by 0.8%. That is for one month, and if you multiply it by 12 to get its annualized affect, you get 9.6%. Now that’s what I call inflation, and it is the worst type. I’ve lived through inflation at 10% before, and you see prices jump in the store each month, and sometimes each week. You become hyper aware of inflation, and how it is eating your savings away. If this inflation persists, I will devote a special edition on what you can do in an inflationary economy to protect yourself, and grow rich as those prices go up.

So, what can the Fed do about this inflation in the teeth of a potential recession (read Greenspan’s words in yesterday’s EconomyGuy)?? Here is the dilemma. The main tool that the Fed has is interest rate adjustments. The second tool the Fed has is the ability to print or destroy money. If the Fed lowers interest rates, it helps the recession, but fuels inflation. If the Fed raises interest rates, it does the opposite. If the Fed adds money to the economy, it helps solve our sub-prime created liquidity crisis, but it fuels inflation (even more than interest rate cuts). And, if the Fed destroys money, it kills off inflation, and drives us straight into the teeth of a recession (or worse.)

The solution to this problem is time and industrial action. It will take time to work our way out of this mess – probably one or two years. It will take industrial action to spend on their plants and infrastructure to keep employment and positive growth going. The Fed, and more importantly Congress, must put in place, and keep in place the ability for industry to act. Congress must not kill off industrial initiative like the New Deal did during our Great Depression, thereby keeping the US in that depression for over a decade. Congress holds the most dangerous powers in this struggle in the economy. I hate saying that because I just don’t think Congress has shown any ability to lead in the face of danger to the US – including economic danger.

Today’s market provided a major vote by stock market players that the possibility of inflation is NOT good for stock prices. The market is getting the seriousness of what’s going on in the real economic world outside of Wall St. Today the Dow went down 178 points.

The bond market continued to vote with its feet, and increased the 10 year bond up to 4.22%. That’s 0.50% higher than it was two weeks ago. That’s what an inflation scare does for you. This is very scary to me. The inflation scare comes from one month’s data on PPI and CPI. One month doesn’t start a trend. It’s only a point on a graph. Two or three months is much more meaningful. If these bond levels persist, you can bet that 30 year and 15 year mortgages will have higher interest rates, and that will slow the housing market even more. (Get the idea how ugly this can get?)

The one surprise today was the strength of the dollar. It increased over 2 cents to the Euro, and increased against all other currencies. This increase was caused by the recent Fed action, and a flight to quality in the currency market. If the US is bailing out the Europeans, who could be next? If the Europeans needed bailing out, it isn’t a great idea to have all your money in Euros. We’ll watch this trend closely.

Here are Friday’s closing details:

DJ30 – 13,340 (Down 178 points)
10 year US Treasury Bond – 4.22% (Up 0.06%)
Euro $1.4424 – an amazing move of down 2 cents
Gold closed at $798 per ounce. (Down $6)
Oil Closed at $91.27 (Down $0.98)
Gasoline is $2.34 (Down $.03) - I just filled up my Jeep for over $50 – yuck.